Small Business Retirement Plan Options and Cautions Detroit MI

With the end of the year approaching, the IRS recently reminded self-employed small business owners that they can deduct contributions they make to retirement plans for themselves and their employees. This includes not only contributions you make to your own plan as a sole proprietor but also any trustee fees not covered by the plan. The notice went on to “provide a quick look at preventing incorrect deductions for retirement plans.” This article offers some additional information and insight that will help business owners avoid disallowed deductions.

Kinds of plans 

Self-employed small business owners have a few choices for what kind of retirement plan to set up.

SEP-IRA: A simplified employee pension (SEP) plan can be set up as an individual retirement account or annuity. For many years this was the first choice of retirement plans for most small business owners because the fees are relatively low and the contribution limits are higher than those for some other types of plans—up to $46,000 or 25 percent of compensation (20 percent of net business income for Schedule C filers) in 2008. The employer must make contributions on behalf of all employees who are at least 21 years old and have worked for the company for at least three of the last five years. The contribution formula can’t discriminate in favor of highly compensated employees.

Individual or "solo" 401(k) plans are the newest variety available to business owners Individual 401(k): The newest kind of retirement plan for self-employed business owners is sometimes referred to as a “solo 401(k).” It is favored by self-employed people without any employees (including leased employees) because it allows the company to make a contribution of up to $15,500 as an “elective deferral.” This contribution is in addition to the profit-sharing contribution of up to the $46,000 or 20 percent of net business income (25 percent of compensation) allowed in a SEP-IRA. Solo 401(k) plans can also cover the spouse of the business owner.

SIMPLE IRA or 401(k): Some companies with at least one and not more than 100 employees choose a SIMPLE plan because these plans allow employees to make elective contributions. The employer can choose either to contribute 2 percent of the employee’s compensation or to match employees’ contributions up to 3 percent of compensation. These plans have lower contribution limits ($10,500 per employee in 2008) and must be set up between January 1 and October 1, except for new businesses. While they limit employers’ financial obligations, they also limit owner-employees’ contributions to their own retirement plans.

For all three kinds of plans, participants age 50 or older can make a “catch-up contribution” of an additional $5,000 in 2008 and $5,500 in 2009.

Cautions from the IRS

In a fact sheet issued in July, the IRS cautioned self-employed business owners...

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